In previous blog posts, we have talked about how the future is uncertain and how we, at Allan Gray, invest for the long-term anyway and embrace uncertainty. But why not choose the opposite? Can one stick to the predictable, invest for the short-term, and still be successful?
When we buy shares of a business, we face the unpredictability of future cash flows that the business may generate. Even though most valuation methodologies rely on forecasting, both science and practice continue to show that long-term forecasts are so inaccurate that they are useless. Near-term forecasts, however, can be more accurate. Why do we therefore choose to invest for the long-term and embrace unpredictability?
Can short-term forecasts be the basis for a successful strategy?
Unfortunately, a short-term focus won’t help you avoid uncertainty. Even though forecasts can be more accurate in the near term, it is very hard to build a successful strategy on these forecasts because a short-term speculator faces two challenges:
- When accurate forecasting is possible, the average of all forecasts is more accurate than any individual forecast, simply because individual biases tend to cancel out – a phenomenon known as ‘The Wisdom of Crowds’. This means that the forecast already reflected in the share price is exceedingly likely to be better than the one made by an individual investor.
- Even if you could consistently make better predictions than the market, the high costs of short-term trading, fees, and taxes would erode your returns.
We invest for the long-term and embrace uncertainty
Instead of attempting to out-forecast the market, we embrace the unpredictability. We focus on business fundamentals and invest for the long-term rather than relying on short-term forecasts. We adopt approaches used successfully in many fields from science, to chess, to warfare: We invest statistically, prepare for the unpredictable, and exploit the market’s tendency to underestimate the degree of uncertainty.